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Benchmarks for Assessing the Potential Impact of a Natural Gas Severance Tax on the Pennsylvania Economy

The Marcellus Shale natural gas play has the potential to provide an important source of energy for the U.S. and to create significant economic impacts for Pennsylvania. However, the Marcellus Shale development opportunity also has generated controversy about its potential environmental, safety, and health impacts.

Whether to impose a severance tax on natural gas produced - and the structure, rate, and exemptions for such a tax - has been a focus of vigorous legislative and public attention and debate. A number of severance tax proposals have been offered. The potential impact of a natural gas severance tax on the Pennsylvania economy has received slight analytical attention, even though the Pennsylvania General Assembly intended to enact a natural gas severance tax by October 1, 2010.

The research reported in this document was designed to estimate the magnitude of the impact on the Pennsylvania economy of a Pennsylvania natural gas severance tax. We benchmarked the impact of every $100 million of revenue collected from a natural gas severance tax between 2011 and 2015 jobs, business sales, income, and population in Pennsylvania. Of course, what is revenue for the Commonwealth is, at the same time, a production cost for Pennsylvania gas producers. For this reason, we treated the revenue collected as a production cost that gas producers cannot pass along to customers. Also, some yet-to-be-decided plan will allocate revenue collected to state government and to local county and municipal governments. Therefore, we also considered the economic consequences for Pennsylvania of spending the severance tax revenue collected under various spending plans.

Severance tax and revenue spending plans that actually have been proposed are not evaluated in our analysis because the revenue yield and spending distribution for each plan have not been specified completely by their proponents. The revenue yields from each plan are dependent on the volume and price of gas extracted, which are factors that are exogenous to any tax structure and rate plan. The spending distribution plans will evolve through fiscal and political negotiation. As a consequence of these information constraints, we chose to benchmark the impact of every $100 million in severance tax revenue collected - treated in our analysis as $100 million of production costs for the Pennsylvania oil and gas industry - on the Pennsylvania economy. In addition, our benchmarks take into account the potential impacts of distributing each $100 million of revenue through state and local spending and through deferring spending by saving some revenue to mitigate environmental, safety, and health problems that might occur in the future. In this way, we seek to provide a yardstick by which various tax and spending plans can be measured.

The REMI Policy Insight model was applied to simulate the outcomes of various scenarios that describe the potential economic and demographic impacts of each $100 million of severance tax collected, along with the current and deferred spending of these tax revenues by state and local authorities. We found that each $100 million of production costs added to the Pennsylvania oil and gas industry from 2011 through 2015 could generate a small impact on Pennsylvania’s economy and demography. Also, each $100 million of spending by state and local governments, even if some is deferred, potentially more than makes up for any losses resulting from each additional $100 million of production costs imposed by a severance tax. The benchmarks for the potential impact of a severance tax on the Pennsylvania economy are subject to numerous cautions, constraints, and uncertainties, some of which are discussed in this report.

The report ends with an open invitation to civil dialogue about the potential impacts of a severance tax using an online discussion forum and social bookmarking tools. This conversation is started in this report with critical comments from two independent reviewers about our estimates of the potential economic and demographic impacts of a severance tax on natural gas extraction.

Our main conclusion is that a severance tax on natural gas extraction in Pennsylvania would increase costs for gas drilling companies, but spending the resulting increase in state revenue generated by the tax could yield positive, but small, impacts on the state’s economy and population.

This report was prepared using the resources and expertise of the Penn State Institute for Research in Training & Development. Planning, conducting, producing, and distributing this report was not funded by any organization, entity, or individual internal or external to Penn State.